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Debt Crisis

By Zhiguo He Y, Wei Xiong Z, Thank Jennie Bai, Long Chen, Douglas Diamond, James Dow, Jennifer Huang, Erwan Morellec, Raghu Rajan, Andrew Robinson, Hong Kee Sul, S. Viswanathan and Xing Zhou


This paper models the e¤ect of debt market liquidity on …rms ’ credit risk through debt rollover. When deterioration of debt market liquidity causes a …rm to su¤er losses in rolling over its maturing debt, equity holders bear the losses while maturing debt holders get paid in full. This con‡ict can lead the …rm to default even when its fundamental is still high. As a result, the liquidity deterioration leads to not only a higher liquidity premium but also a higher default premium. Our model explains ‡ight to quality and demonstrates the role of short-term debt in exacerbating rollover risk

Topics: An earlier draft of this paper was circulated under the title “Liquidity and Short-term Debt Crises”
Year: 2010
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